Can anyone explain the following materiality question?

UK Discussion in 'Exams and Studying' started by mi2017, Apr 10, 2017.

  1. mi2017

    mi2017

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    I am struggling to understand the concept of materiality and why in this question the 5% has been set on the profit after tax?

    So far I have prepared my answer:

    Prepared answer: that the financial statements would not be comparable and what might be a considered immaterial one year might not be immaterial the next

    however I am struggling to understand:

    - Why this figure was set on profit after tax?
    - What might be the problems of using that figure rather than another?
    - To which items in the financial statements will it not apply?

    Question: An accountant has set a limit of 5% of profit after tax for materiality in the draft financial statements, so that errors below 5% of profit when aggregated will be regarded as immaterial and not adjusted when the final financial statements are prepared.

    What might be the problems of using that figure rather than another? To which items in the financial statements will it not apply?
     
    mi2017, Apr 10, 2017
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  2. mi2017

    Fidget VIP Member

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    There are auditing benchmarks, or 'rules of thumb' for materiality. General benchmarks for me are:

    * Revenue - 0.5% to 1%
    * Gross Profit - 0.5% to 1%
    * Profit before Tax - 5%
    * Profit after tax - 5% to 10%
    * Total Assets - 1% to 2%
    * Net Assets - 2% to 5%

    There isn't an absolute rule when it comes to materiality, so those I've just mentioned aren't gospel or anything.

    You could probably swap the word "material" for "important", or "significant" (that's a good one for auditing). So, the concept of materiality in financial statements is one of how important/significant something is in the accounts when taken as a measurement against something else.

    * So, in your case scenario it has been set at 5% on profit after tax. So... profit after tax? Where do you find that in your financial statements? That should tell you which items it is 'not' going to affect because the items it doesn't affect are in the other financial statement.

    * Problems using that fig and not another. Well.. you could probably go to town with this. If you set a benchmark and ignore anything below it, then you might miss something big just because it fell below your benchmark. And how did you get to that benchmark anyway? You have take a lot into consideration. How well do you know the client? For how long have you been their accountant/auditor? How well do you know the business they are in? Are there external things affecting the their trade: recessions, new technologies, basically anything that might affect the business enough to have an impact on its financial statements.

    I know it can be a bit confusing, but hopefully this is more of a help than a hindrance.
     
    Fidget, Apr 17, 2017
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